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The stability of efficiency rankings when risk-preferences and objectives are different

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  • Koetter, Michael

Abstract

We analyze the stability of efficiency rankings of German universal banks between 1993 and 2004. First, we estimate traditional efficiency scores with stochastic cost and alternative profit frontier analysis. Then, we explicitly allow for different risk preferences and measure efficiency with a structural model based on utility maximization. Using the almost ideal demand system, we estimate input and profit demand functions to obtain proxies for expected return and risk. Efficiency is then measured in this risk-return space. Mean risk-return efficiency is somewhat higher than cost and considerably higher than profit efficiency. More importantly, rankorder correlation between these measures are low or even negative. This suggests that best-practice institutes should not be identified on the basis of traditional efficiency measures alone. Apparently, low cost and/or profit efficiency may merely result from alternative yet efficiently chosen risk-return trade-offs. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2006,08.

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Date of creation: 2006
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Handle: RePEc:zbw:bubdp2:5096

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Keywords: Risk; efficiency; banks; Germany;

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Citations

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Cited by:
  1. Joseph P. Hughes & Loretta J. Mester, 2008. "Efficiency in banking: theory, practice, and evidence," Working Papers 08-1, Federal Reserve Bank of Philadelphia.
  2. Joseph P. Hughes & Loretta J. Mester, 2013. "Measuring the performance of banks: theory, practice, evidence, and some policy implications," Working Papers 13-31, Federal Reserve Bank of Philadelphia.
  3. Li-Gang Liu & Changchun Hua, 2010. "Risk-return Efficiency, Financial Distress Risk, and Bank Financial Strength Ratings," Working Papers id:2944, eSocialSciences.
  4. De Jonghe, O.G. & Disli, M. & Schoors, K., 2011. "Corporate Governance, Opaque Bank Activities, and Risk/Return Efficiency: Pre- and Post-Crisis Evidence from Turkey," Discussion Paper, Tilburg University, Center for Economic Research 2011-129, Tilburg University, Center for Economic Research.

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